Abstract: As investors adjust portfolios at different speeds, quantitative tightening shifts the composition of the marginal investors, which makes the Treasury market fragile. We show empirical evidence for the shift in investor composition, and develop a general equilibrium model of bond valuation with heterogeneous investors to understand its implications. In the model, long-term bond investors have higher risk-taking capacity, but face a portfolio adjustment cost; liquidity traders have lower risk-taking capacity, but can trade freely. Our model predicts a novel overshooting pattern: when the central bank unwinds its bond purchases, slow adjustment by long-term investors requires liq- uidity traders to absorb the imbalances, who demand a high risk premium and lower the bond price below the long-run level. As a result, quantitative tightening is not simply a symmetric reversal of quantitative easing.
Abstract: The Fed argues that quantitative easing (QE) lowers yields across asset markets via the portfolio rebalancing channel. I provide a direct test for this channel, quantify its magnitude, and document its real effects. I first construct a novel QE shock measuring the unexpected amount that the Fed purchases of each Treasury during each QE operation. Combining this shock with holdings data, I find that investors rebalance over 60% of proceeds from QE-induced Treasury sales into corporate bonds, predominantly into bonds with similar maturities to those the Fed purchased and bonds issued by firms whose bonds they already own. Consistent with the portfolio rebalancing channel, the yields of these bonds fall. To quantify the channel’s magnitude, I use my reduced-form estimates to calibrate a preferred habitat model with investors who substitute between Treasurys and corporate bonds. I find a large effect: $100 billion of Treasury purchases lower corporate bond yields by 8bps on impact, with the effect dissipating over the following year. Turning to real effects, I find that affected firms increase bond issuance and do so at lower yields. Firms use the funds to increase their capital investment and cash buffers. Overall, the results point to a strong portfolio rebalancing channel.
Abstract: This paper examines how unconventional monetary policy affects asset prices and macroeconomic
conditions by reallocating risk in the economy. I consider an environment with two main
ingredients: heterogeneity in risk tolerance and frictions in portfolio adjustment. Risk-tolerant investors
take leveraged positions, exposing the economy to balance-sheet recessions. The central
bank’s balance sheet is non-neutral due to the presence of passive investors. Unconventional monetary
policy reduces the risk premium and endogenous volatility. Asset purchases boost investment
and growth during crisis, but reduce them during normal times. The intervention reduces risktaking
by leveraged institutions. As risk concentration falls, the probability of negative tail-events
is reduced, enhancing financial stability. Under the optimal policy, the central bank should increase
its exposure to risk, which is inconsistent with increasing holdings of long-term government bonds.
